Investors withdrew money from emerging market bonds and stocks at the fastest pace since March 2021, as fears over monetary policy tightening, the post-pandemic economic recovery and geopolitical frictions worsened the outlook. .
Foreign investment in emerging market stocks and bonds outside of China has “suddenly come to a halt”, the IIF said in its January capital flow monitoring report on Friday.
“We believe the outlook is worsened by the Omicron variant and higher US interest rate expectations,” the report said.
“Overall, the first month of the year saw heightened market volatility, pushing investors out of emerging market stocks.”
Rising inflation is a major concern for policymakers across the emerging market landscape, with 18 of the top 20 central banks tightening monetary policy, which has consequently dampened bond flows. The annual rate of inflation in the euro zone has climbed to 5.1%, figures released earlier this week showed. US inflation data, to be released on February 10, is also expected to show that basic prices (excluding energy) rose 5.9% annually in January.
“Developed market equity market jitters have spread and we see emerging markets, excluding Chinese equities, with outflows of $3.2 billion,” the IIF report said.
Emerging debt excluding China suffered an outflow of $4.5 billion, despite the good performance of local currency bonds in many markets.
However, bonds in China received $9 billion in flows last month thanks to policy measures by the country’s central bank. The divide between Chinese and non-Chinese emerging markets is “rooted” in growth, with the world’s second-largest economy set to rebound faster.
“Going forward, we see more differentiation in flow dynamics as some countries have bottomed out and could potentially benefit from rising commodity prices and possible central bank accommodation. However, if market volatility persists, the outlook could deteriorate,” the IIF said.
Separately, the Washington-based institute said the U.S. economy had nearly returned to its pre-pandemic growth trend, rebounding much faster than after the global financial crisis, an outlier compared to other G10 economies.
The IIF also signaled a weaker recovery in the Eurozone, where the picture for consumption and investment looks less compelling.
“Nowhere in the euro area has private consumption picked up as much as in the United States,” he said. “Consumption levels remain particularly depressed in Italy and Spain.”
The European Central Bank made a policy reversal on Thursday, acknowledging growing inflation risks and opening the door to a possible interest rate hike this year.
ECB President Christine Lagarde said that while inflation is expected to remain high for longer than expected, it will decline over the course of this year.
However, compared to December expectations, risks to the inflation outlook are on the upside, particularly in the near term as “the situation has indeed changed”, she said a press conference.
While Ms Lagarde said the ECB would not rush, she declined to repeat her previous advice that an interest rate hike this year was “very unlikely”.
Updated: February 4, 2022, 8:25 a.m.